It’s widely known we VCs focus on just a couple of key dimensions when making our investment decisions:  team, market, product / technology, and investment parameters or “deal”.  While all of these parameters are loosely connected and there are many paths to “yes” at the end of the day market size is the prime reason VCs pass on otherwise credible opportunities.

It’s well known VC’s love markets that are huge in size, but what’s sufficiently big for a market to be attractive to VCs?  It starts with an honest appraisal of TAM.

TAM =  “Truly” Addressable Market –> Wikipedia would have you believe that TAM stands for total addressable market.  But as a VC, I typically think of it as “truly” addressable.  If market is the chief dimension on which VC’s pass, market size is the chief element of that.  VCs invest in disruptive startups that have the potential to build large ($100M+ revenue, enterprise value of hundreds of millions to billions) and durable businesses.  It’s hard for startups to capture more than a small fraction (10% or less) of a market, therefore a market must be measured in the billions for a VC to believe there’s a credible chance a startup can be a “venture scale” business.

But in the abstract, anyone can say that the market for X is some astronomically high number.  What matters is the amount of money truly spent on a startup’s product or service.  There’s $100B+ spent each year on plane flights, hotels, and rental cars in the US… but if you’re an upstart online travel service, you’re not competing for those dollars unless you actually own a fleet of planes, rental cars, and a bunch of hotels.  You’re typically competing for the dollars spent by companies that own fleets of planes, rental cars, and hotels to promote their services to travelers.  It turns out that itself is a pretty big market which is why many big businesses have been built there (Priceline, Kayak, TripAdvisor, Expedia, Hotwire, etc).  But conflating the market for hotel rooms with the market for online promotion by companies that offer hotel rooms will hinder your chances of raising capital.

Understanding and pitching the market size which is truly addressable for your startup is critical, and VCs only love markets that are large in “truly” addressable size.  A marketplace’s true revenue potential is the % of the total GMS (gross merchandise sales) they can charge (typically 5-10%), not the total GMS.  A payments company’s true revenue potential is the % of the payment volume they can charge to process those transactions (typically 2-4% on a gross basis, <1% on a net basis), not the total payment volume.  Conversely when a startup’s service truly is a substitute in a monstrously large market, these companies can be massively valuable (e.g. Uber, AirBnB).

VCs will not ignore adjacent markets or the possibility of expanding beyond a startup’s home country, but will tend to discount both in the short run.  While it’s certainly possible for a startup to build new products to serve adjacent markets and it’s easier to expand internet & software businesses globally today than a decade ago, neither are easy to do in the first 0-5 years of a startup’s life.  Some services, both consumer & B2B, face localization challenges or cultural differences in expanding or building a strong brand in one market segment may actually make it more challenging to expand into others.  So highlighting adjacent or international markets can be useful examples of how a startup’s truly addressable market expands naturally over time, but typically VC’s will focus on the core/home market.

So think honestly and hard in defining your startup’s TAM.  That which is truly addressable is what will increase the chances of getting to yes with VCs.